6 Apr 2009

Monopolistic Conservation

NW says
You mention in this blog post that "the best conservationist is a monopolist", because monopolistic profits "result when quantity is withheld from the market and prices rise", and you cite OPEC as an example [1].

What type of good does this logic apply to? I ask this because, clearly, there are examples of natural resources that are not monopolized, like oil (at least in countries where oil isn't nationalized). What about metals in mines, timber in forests, or, even more broadly, land in ecologically sensitive areas? If a monopoly is best at conserving water, then shouldn't we monopolize all of these other resources [2]? If we should, then don't we lose the benefits of markets in allocating scarce resources [3]?

My understanding of the classification of goods (private, common, public, club) isn't great, especially when it comes to its relationship with what normative economics considers to be the best ownership structure for each type [4]... I would appreciate a blog post for clarifying the above questions and/or the general concept of what the best ownership structure is for a particular type of good.
Excellent questions, and here are my answers -- indexed by the numbers above:
  1. A monopoly is defined as a single seller facing multiple buyers. As such, the monopoly has "market power" to affect the price of the good -- usually by limiting the quantity of the good available. Given competition among buyers for that limited supply, the price where the quantity demanded equals that limited supply will be higher than when there were more units of the good available. The benefit of higher prices goes to the monopolist in the form of higher profits. Note that a monopolist NEED NOT restrict quantity (water agencies often do not), but a profit-maximizing firm will.

    Important caveat: Because monopolies lower the quantity of good available in the market, they reduce the total surplus (buyer + seller surplus). Such an outcome is "bad" when the price of the good reflects all externalities (e.g., the market for haircuts), but it may NOT be bad if the price is "too low," e.g., the market for coal, oil, water...

  2. Monopolist practices can apply to any good. It's a question of the number of sellers, not the characteristic of the good (assuming that it's a private good -- see 4). Monopolistic pricing can reduce the quantity of oil, water, diamonds, baseball players, etc. Even when there is some competition (e.g., OPEC or Debeers), "oligopolistic competition [sic]" can result in higher prices than when there is perfect competition, i.e., no firm can affect prices by reducing supply.

  3. Markets are STILL good at allocating the reduced supply -- to those willing to pay the most. The alternative (bureaucratic allocation or bilateral negotiation) often awards the good to the wrong demanders -- either because of information asymmetry (buyers SAY they "need" the good), corruption (they bribe for access), or higher transactions costs (it's hard to find the right buyer).

  4. Ownership structure often follows from the characteristics of the good (broadcast radio is a public good, but apples are private goods), but it can also change with property rights. Groundwater is a rival good (if I use it, you cannot) but property rights will determine if it's private (excludable) or common pool (non-excludable). If property rights are such that the groundwater is a common-pool good, then it will be "over-exploited." That's why economists advocate adjudication of groundwater rights, and why the Tragedy of the Commons refers to the overgrazing of a town common when everyone can graze their sheep on it. (The same holds for fish in the open sea.)
Bottom Line: Property rights are often the difference between a resource that's sustainably managed and a resource that's overexploited. Since overexploitation harms everyone in a society, it's important to get property rights right.


Eric said...

Thanks for starting this thread.

I would like some real examples and their consequences. Especially interesting to me would be goods such as oil, electricity, automotive, computers, and telecommunications that changed classifications over time and sometimes changed back.

David Zetland said...

Eric: bad monopoly to good competition: postal service.

bad competition to good monopoly: ITQs for fisheries.

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